Times Preferences and Budget Cuts

The more impatient households are to consume, the greater the impact of government spending cuts on economic growth, according to a paper published by the Bank of England Friday.

Co-authored by Monetary Policy Committee member David Miles, the paper argues that differences in “time preference” — or the degree to which households wish to buy goods and services now rather than in the future — play a big part in determining national attitudes towards the pace of budget cuts.

Mr. Miles and fellow author Gilberto Marcheggiano of Goldman Sachs Asset Management conclude that because their people are more patient, budget cuts in Germany and other northern European nations have a smaller impact on growth than in southern Europe, where consumers are less patient.

“Our findings may help to explain some of the differences in view over the optimal path for fiscal consolidation in Europe today, between the Germanic and Northern European countries — whose representatives appear to favour a faster fiscal retrenchment — and those in the South — who would like their required fiscal adjustment to occur less rapidly,” they wrote.

The size of the fiscal multiplier — which measures the impact that government spending cuts have on economic output — has been the focus of intense debate in the years since the financial crisis and the economic slowdown that followed sent government debts soaring across much of the developed world.

Recently, the International Monetary Fund, the Organization for Economic Cooperation and Development and the European Commission have acknowledged that they have underestimated the negative impact of budget cuts on growth.

Although each have had slightly different reasons for reaching that conclusion, they argue that in contrast to previous periods of fiscal consolidation, during the current phase monetary policy was already so stimulative it could offer little additional support to the economy, while the fact that consolidation is being carried out by a large number of countries means that export growth has not offered a way of offsetting the impact.

Mr. Miles and Mr. Marcheggiano take a different approach, and their conclusions also offer a explanation as to why fiscal consolidation may have inflicted more damage on southern Europe than policy makers anticipated.

“The countries in Europe where fiscal deficits and debt levels are highest are largely in the south, where average rates of time preference seem to be greatest and where fiscal multipliers – and so the cost of reducing deficits rapidly – would tend to be larger,” they write.

They make no comment on fiscal multipliers in the U.K., which is itself pursuing a program of fiscal consolidation. Since the government embarked on that program in mid-2010, the economy has grown by just 0.5%, and remains smaller than its 2008 peak.

But according to data the authors use to determine whether consumers are patient or impatient, the UK sits between northern European nations such as Germany and southern European nations such as Spain.